www.ssresearcher.com ISSN 2321­8258 T HE J O U R N A L O F E C O N O M IC R E V IE W
FSSR
www.ssresearcher.com
APRIL 2013
VOLUME I NO I
MONOPOLISTIC COMPETITION
REFERENCE TO INDIA
OF
FARM
ECONOMY-
SPECIAL
MR.KANCHAN DHARA
ASSISTANT TEACHER
GHATAL COLLEGE
MURSHIDABAD
ABSTRACT
Monopolistic competition is a type of imperfect competition such that many
producers sell products that are differentiated from one another as goods but not
perfect substitutes (such as from branding, quality, or location). In monopolistic
competition, a firm takes the prices charged by its rivals as given and ignores the
impact of its own prices on the prices of other firms. In a monopolistically
competitive market, firms can behave like monopolies in the short run, including
by using market power to generate profit. In the long run, however, other firms
enter the market and the benefits of differentiation decrease with competition; the
market becomes more like a perfectly competitive one where firms cannot gain
economic profit. In practice, however, if consumer rationality/innovativeness is
low and heuristics are preferred, monopolistic competition can fall into natural
monopoly, even in the complete absence of government intervention. In the
presence of coercive government, monopolistic competition will fall
into government-granted monopoly. Unlike perfect competition, the firm maintains
spare capacity.
THE JOURNAL OF ECONOMIC REVIEW APRIL 2013 24 www.ssresearcher.com ISSN 2321­8258 DISCUSSION
Models of monopolistic competition are often used to model industries. Textbook
examples of industries with market structures similar to monopolistic competition
include restaurants, cereal, clothing, shoes, and service industries in large cities.
The "founding father" of the theory of monopolistic competition is Edward
Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of
Monopolistic Competition (1933). Joan Robinson published a book The
Economics of imperfect competition with a comparable theme of distinguishing
perfect from imperfect competition.
Monopolistically competitive markets have the following characteristics:
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There are many producers and many consumers in the market, and no business
has total control over the market price.
Consumers perceive that there are non-price differences among the competitors'
products.
There are few barriers to entry and exit.
Producers have a degree of control over price.
The long-run characteristics of a monopolistically competitive market are almost
the same as a perfectly competitive market. Two differences between the two are
that monopolistic competition produces heterogeneous products and that
monopolistic competition involves a great deal of non-price competition, which is
based on subtle product differentiation. A firm making profits in the short run will
nonetheless only break even in the long run because demand will decrease and
average total cost will increase. This means in the long run, a monopolistically
competitive firm will make zero economic profit. This illustrates the amount of
influence the firm has over the market; because of brand loyalty, it can raise its
prices without losing all of its customers. This means that an individual firm's
demand curve is downward sloping, in contrast to perfect competition, which has
a perfectly elastic demand schedule.
MAJOR CHARACTERISTICS
There are six characteristics of monopolistic competition (MC):
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Product differentiation
Many firms
Free entry and exit in the long run
Independent decision making
Market Power
Buyers and Sellers do not have perfect information (Imperfect Information)
THE JOURNAL OF ECONOMIC REVIEW APRIL 2013 25 www.ssresearcher.com ISSN 2321­8258 PRODUCT DIFFERENTIATION
MC firms sell products that have real or perceived non-price differences. However,
the differences are not so great as to eliminate other goods as substitutes.
Technically, the cross price elasticity of demand between goods in such a market is
positive. In fact, the XED would be high. MC goods are best described as close but
imperfect substitutes. The goods perform the same basic functions but have
differences in qualities such as type, style, quality, reputation, appearance, and
location that tend to distinguish them from each other. For example, the basic
function of motor vehicles is basically the same - to move people and objects from
point A to B in reasonable comfort and safety. Yet there are many different types
of motor vehicles such as motor scooters, motor cycles, trucks, cars and SUVs and
many variations even within these categories.
GROUP OF FARM
There are many firms in each MC product group and many firms on the side lines
prepared to enter the market. A product group is a "collection of similar
products". The fact that there are "many firms" gives each MC firm the freedom to
set prices without engaging in strategic decision making regarding the prices of
other firms and each firm's actions have a negligible impact on the market. For
example, a firm could cut prices and increase sales without fear that its actions will
prompt retaliatory responses from competitors.
How many firms will an MC market structure support at market equilibrium? The
answer depends on factors such as fixed costs, economies of scale and the degree
of product differentiation. For example, the higher the fixed costs, the fewer firms
the market will support. Also the greater the degree of product differentiation - the
more the firm can separate itself from the pack - the fewer firms there will be at
market equilibrium.
FREE ENTRY AND EXIT
In the long run there is free entry and exit. There are numerous firms waiting to
enter the market each with its own "unique" product or in pursuit of positive profits
and any firm unable to cover its costs can leave the market without incurring
liquidation costs. This assumption implies that there are low start up costs, no sunk
costs and no exit costs. The cost of entering and exit is very low.
INDEPENDENT DECISION MAKING
Each MC firm independently sets the terms of exchange for its product. The firm
gives no consideration to what effect its decision may have on competitors. The
theory is that any action will have such a negligible effect on the overall market
demand that an MC firm can act without fear of prompting heightened
THE JOURNAL OF ECONOMIC REVIEW APRIL 2013 26 www.ssresearcher.com ISSN 2321­8258 competition. In other words each firm feels free to set prices as if it were a
monopoly rather than an oligopoly.
MARKET POWER
MC firms have some degree of market power. Market power means that the firm
has control over the terms and conditions of exchange. An MC firm can raise it
prices without losing all its customers. The firm can also lower prices without
triggering a potentially ruinous price war with competitors. The source of an MC
firm's market power is not barriers to entry since they are low. Rather, an MC firm
has market power because it has relatively few competitors, those competitors do
not engage in strategic decision making and the firms sells differentiated
product. Market power also means that an MC firm faces a downward sloping
demand curve. The demand curve is highly elastic although not "flat".
INEFFICIENCY
There are two sources of inefficiency in the MC market structure. First, at its
optimum output the firm charges a price that exceeds marginal costs, The MC firm
maximizes profits where p = MC. Since the MC firm's demand curve is downward
sloping this means that the firm will be charging a price that exceeds marginal
costs. The monopoly power possessed by an MC firm means that at its profit
maximizing level of production there will be a net loss of consumer (and producer)
surplus. The second source of inefficiency is the fact that MC firms operate with
excess capacity. That is, the MC firm's profit maximizing output is less than the
output associated with minimum average cost. Both a PC and MC firm will operate
at a point where demand or price equals average cost. For a PC firm this
equilibrium condition occurs where the perfectly elastic demand curve equals
minimum average cost. A MC firm’s demand curve is not flat but is downward
sloping. Thus in the long run the demand curve will be tangential to the long run
average cost curve at a point to the left of its minimum. The result is excess
capacity.
PROBLEM
While monopolistically competitive firms are inefficient, it is usually the case that
the costs of regulating prices for every product that is sold in monopolistic
competition far exceed the benefits of such regulation. However, it would not have
to regulate every product and every firm just the most important ones. That alone
would be an improvement on the current situation. A monopolistically competitive
firm might be said to be marginally inefficient because the firm produces at an
output where average total cost is not a minimum. A monopolistically competitive
market is productively inefficient market structure because marginal cost is less
than price in the long run. Monopolistically competitive markets are also
THE JOURNAL OF ECONOMIC REVIEW APRIL 2013 27 www.ssresearcher.com ISSN 2321­8258 allocatively inefficient, as the price given is higher than Marginal cost. Product
differentiation increases total utility by better meeting people's wants than
homogenous products in a perfectly competitive market.
Another concern is that monopolistic competition fosters advertising and the
creation of brand names. Advertising induces customers into spending more on
products because of the name associated with them rather than because of rational
factors. Defenders of advertising dispute this, arguing that brand names can
represent a guarantee of quality and that advertising helps reduce the cost to
consumers of weighing the tradeoffs of numerous competing brands. There are
unique information and information processing costs associated with selecting a
brand in a monopolistically competitive environment. In a monopoly market, the
consumer is faced with a single brand, making information gathering relatively
inexpensive. In a perfectly competitive industry, the consumer is faced with many
brands, but because the brands are virtually identical information gathering is also
relatively inexpensive. In a monopolistically competitive market, the consumer
must collect and process information on a large number of different brands to be
able to select the best of them. In many cases, the cost of gathering information
necessary to selecting the best brand can exceed the benefit of consuming the best
brand instead of a randomly selected brand. The result is that the consumer is
confused. Some brands gain prestige value and can extract an additional price for
that.
Evidence suggests that consumers use information obtained from advertising not
only to assess the single brand advertised, but also to infer the possible existence of
brands that the consumer has, heretofore, not observed, as well as to infer
consumer satisfaction with brands similar to the advertised brand.
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